Regular readers will know that I’ve had my doubts about Bitcoin. Recent events in the Bitcoin world, especially the failure of Mt. Gox, the biggest Bitcoin exchange, have caused further problems for the crypto currency. But I’m oddly cheered by these events and am beginning to think Bitcoin may actually have a chance of surviving as a currency.

Willy Sutton, who made his career robbing banks, once explained that he robbed them “because that’s where the money is.” Well recent bad news in the world of Bitcoin follows a similar theme: yes there have been thefts, corruption, and a suicide, but all this is based not on Bitcoin’s failure but on its success. The wonder isn’t that Mt. Gox lost $460 million in Bitcoins but that they had $460 million in Bitcoins to lose.

These events are growing pains, nothing else, and the fact that Bitcoin values have staggered each time and then quickly recovered shows that the market also believes this to be true.

All the recent breaches (if they are breaches — there’s some question now in the case of Mt. Gox) have been based on bad security at these sites. Mt.Gox was run by a Magic the Gathering site. Big money attracts sophisticated teams of hackers, which is why real banks hire sophisticated people to protect them. Dudes running Magic the Gathering sites aren’t that. They don’t have a chance. So look for more Bitcoin exchanges to fall until security standards rise enough to make such thefts less attractive.

Bitcoin itself has remained secure so far. Owning your Bitcoin yourself (encrypted, on your own machine with backups) is still quite safe. The issue is that if a machine with Bitcoins on it can be compromised, the Bitcoins can be sent away anonymously. They are ridiculously easy to fence.

The bottom line is there appears to be a real niche for pseudonymous currency, even if mainly for the subversive world. Also, it opens new doors for electronic payments.

Famed economist Nouriel Roubini — Dr. Doom from New York University — claims Bitcoin is a Ponzi scheme which makes me like the currency more and more. It makes sense he’d see it that way but then the Argentinian peso feels pretty Ponzilike today, too. Only time will tell but if the value endures then it’s not a scheme. It’s weird, but not a scheme.

So if Bitcoin gets killed it will probably be because of something that replaces it.

51 Comments

Martink
March 12, 2014 at 4:14 pm

Thanks for your story Robert, always appreciate you articles and hope you do keep them up.
I agree that, though it has some major hurdles to clear, bitcoin has some chance becoming legitimate. I have stood up for it in the past on this site, weakly. I’m actually surprised bitcoins are vulnerable to a single point of attack (a single site), well except for those stored/owned on that site. Does that mean Mt Gox only lost money it had rather than money for people who traded through Mt Gox? which is what you seem to be suggesting.
Also can anyone refer me to the technical details of bitcoin protocol, wikipedia didn’t have much though I’ll check the links again.

Martink
March 12, 2014 at 5:29 pm

I wasn’t very clear on:
“Does that mean Mt Gox only lost money it had rather than money for people who traded through Mt Gox? which is what you seem to be suggesting.”
I meant Robert X was suggesting that GOX0 only lost it’s own money.

– I know I could just look up the news which I will do though I think I would have to dig a little to get proper details. And I now remember the reports did say punters lost money not just GOX. (If Americans don’t know what punter means, I mean people trading on GOX).

Ronc
March 12, 2014 at 5:37 pm

You asked “Does that mean Mt Gox only lost money it had rather than money for people who traded through Mt Gox?” Like a bank without FDIC or similar insurance, it lost the money in its possession which includes money people left in their Mt. Gox account for convenient transfer to other currencies. But people who took their bit coins offline and stored them on a disk or drive would still have them, just like people who kept their money at home instead of at a bank would be protected from a bank failure.

Martin
March 13, 2014 at 11:49 am

Did Bitcoin only lose the money it had? Yes. but it made things a lot worse by consistently failing / refusing to pay out money owed to clients. You should treat exchanges like exchanges – pay one currency in and withdraw the other one. Except that from last year, Bitcoin firstly went very very slow then claimed a variety of technical difficulties to prevent any withdrawals, right up until they shut their doors for good.

A bank that did that would be in breach of loads of laws – except that Mt Gox wasn’t a bank.

Ronc
March 13, 2014 at 5:02 pm

Re: your comment “Did Bitcoin only lose the money it had? Yes. but it made things a lot worse by consistently failing / refusing to pay out money owed to clients.” The point is that if they loose money “they had”, that includes money owed to clients who kept their money in an account with Mt. Gox. Ethically, as soon as they discovered they lost any part of the money owed to account holders, they should stop paying anyone until the percentage of money left to distribute is known, so that each account holder’s account value can be reduced accordingly. It would be unfair to pay some clients in full, and others only partially.

R
March 14, 2014 at 1:47 am

You seem to have confused Mt. Gox with Bitcoin. Mt. Gox has reportedly lost its Bitcoins, but the Bitcoin system is still running.

Other exchanges are still in business, and my personal Bitcoins are still in my wallet. I made an account on Mt. Gox and sent a Bitcoin there, but it was so difficult to get dollars out of Mt. Gox that I just sent that Bitcoin back to my wallet. My financial exposure to Mt. Gox’s collapse is minimal.

Ronc
March 14, 2014 at 5:02 pm

Sounds like you did the equivalent of depositing a dollar in a bank account and told the bank “I’d like to keep the dollar in my wallet as well as my account, if you don’t mind, just in case your bank fails and you loose all the money in my account.” If everyone could just go to another exchange, then it wouldn’t matter if an exchange looses all the bitcoins it had, and the value (popularity) would not have plummeted. I don’t see how the same bitcoin can be in your possession and in the exchange’s possession at the same time.

Ronc
March 14, 2014 at 5:14 pm

OTOH, you said “…but it was so difficult to get dollars out of Mt. Gox that I just sent that Bitcoin back to my wallet…” So perhaps you were just one of the luck ones who got out soon enough, before the so-called “run on the bank”.

R
March 16, 2014 at 10:46 pm

Yeah, I was just lucky. I was trying to cash out some Bitcoins for the first time, and Mt. Gox had the highest exchange prices. Like, Coinbase was buying Bitcoins for $400, while Mt. Gox was trading them for $500.

But when I tried to find a way to transfer dollars out of Mt. Gox, I couldn’t find any. Their Wells Fargo and Dwolla accounts were seized in May, so they could only transfer money by international money order, which had a multi-month backlog already. Furthermore, their interface was messed up, so I couldn’t enter my particular bank’s account into the form.

So I just cashed my Bitcoins using Coinbase and CampBX. Which, by the way, are still running.

Bruce Hoult
March 12, 2014 at 4:24 pm

Well, you can’t beat the source, for however technical you want to get:

Thanks for that Bruce, I’m sure that link is on Wikipedia though I looked for links like bitcoin.org, maybe the “.it” threw me off. I’ll have a look.

DE
March 12, 2014 at 4:46 pm

All currencies are Ponzi schemes initially.

David W.
March 12, 2014 at 6:25 pm

Not quite. A currency has a demand simply because the country that creates the currency creates the demand: You have to pay your taxes in it. You will need to obtain some of that currency if you want to stay out of the hoosegow. If someone has some of that currency, and you have something that person wants, you can trade. It’s what makes fiat currency a fiat currency. Other forms of non-fiat currency like gold, tea, and beaver pelts have intrinsic value. Even if you can’t pay Uncle Sam in pressed tea-blocks, it still has value because people like tea. Bitcoins has no intrinsic value, and it has no fiat demand. There’s nothing holding it up at all.

Buckaroo Banzai
March 13, 2014 at 8:22 am

“Bitcoins has no intrinsic value, and it has no fiat demand. There’s nothing holding it up at all.”

Wrong. A currency does not need to have intrinsic value to function as a currency. It just needs a critical mass of people willing to use it as a medium if exchange.

You are confused because “money” has three different defining characteristics: (1) store of value, (2) medium of exchange, and (3) unit of account. Note that something can be useful as “money” even if it only fulfills one or two of those qualities.

Bitcoin is useful as a medium of exchange because it is extremely well suited to electronic transactions over the internet. As people grasp the obviousness of this fact, they become more willing to use it as such.

If you think “intrinsic value” makes for good money, consider gold. It really has very little intrinsic value because it is actually pretty useless when compared to other metals. But, due to its scarcity, durability, ductility, and the fact that it doesn’t corrode, that makes it intrinsically useful for only one function: to serve as money!

You must be thinking of some other metal when you say that the only use of gold is as money. Gold has a substantial demand for use as jewelry and it also is used in various industrial applications.
.
The problem with using fiat currency as money is the tendency of governments to devalue the currency by issuing too much of it. Fiat currency is created out of thin air and has no natural limits of how much can be issued.

Buckaroo Banzai
March 13, 2014 at 3:25 pm

Charles, jewelry is not a practical use, it is an ornamental use. “Intrinsic value” generally implies being useful in daily life. As far as gold’s industrial uses– only about 15% of gold production is used industrially, and if necessary other metals could substitute adequately for most of those uses. If gold was still used as currency, it’s value would be much higher, and probably wouldn’t be used economically for anything but the most critical of industrial uses.

Ronc
March 13, 2014 at 5:12 pm

Re: “Charles, jewelry is not a practical use, it is an ornamental use.” I think someone has just jumped the shark. That’s the type of reasoning that was the downfall of communism. The point is that the true determination of value is an individual decision based on differing opinions of buyers and sellers.

MikeN
March 15, 2014 at 1:24 pm

Almost all of the gold that has ever been dug up is sitting in banks and warehouses, not being used. About 1% of dug up amount is used every year by industry. If it were not a currency, the original bitcoin, its value would collapse.

David W.
March 12, 2014 at 6:11 pm

The first question should be “Why hasn’t Bitcoin failed?”. Miilions of dollars in bitcoins have been lost in private wallets. The ones In-the-Know tell you to keep your coins on USB sticks — in fact multiple USB sticks in case they get lost or stolen and keep them off the Internet until you’re ready to use them. And, Mt. Gox isn’t the first “exchange” or “bank” to fail. but it was the biggest losing 7% of all Bitcoins in the world. If a country had such a financial system, it would have been carted off by the IMF and sold for scrap.

So, what keeps Bitcoins from crashing? First, few Bitcoins are traded. Over 90% of the Bitcoins sit in the wallets of speculators unspent. With such a small market, it’s easy to manipulate the price– just ask any pump-n-dump dealer of penny stocks. Second, there is a very large concentration of bitcoins in few hands. Less than 50 people control about 30% of all bitcoins. Half of all bitcoins are held by less than 1000 people. If you own that much in a single investment (and there’s an excellent chance that almost all of their wealth is in bitcoins), you will do whatever you can to make sure that investment’s price doesn’t drop. Only when these people have used up every single penny of their non-Bitcoin assets will we see the price plunge.

Sam
March 12, 2014 at 7:06 pm

The Peso in Argentina is expected to lose 30% of its value in 2014.

Inflation – not just for breakfast any more.

Ed
March 13, 2014 at 8:20 am

The Argentinian peso is worth every ounce of the full faith and credit of the Argentinian government. That’s all you need to know.

Ronc
March 13, 2014 at 5:17 pm

The same comment applies to our government and our currency. That would partially explain the flight to Bitcoin.

Mark
March 12, 2014 at 7:40 pm

The key to watch in Bitcoins is the integrity of the network. Thefts are to be expected and aren’t a threat. But if the P2P system were to break down it would be the end. The bug that hit the network with the version upgrade from (iirc) 0.7 to 0.8 scared me quite a bit.

My strategy is never put real $$ into bitcoins. I mined a few back when GPU’s were profitable. I used some to buy some hardware, but I expect it to arrive to late to make more than I spent. I the rest on paper and put them in the safe deposit box. Who knows, some day I may be a multi-thousandaire!!!

Robert
March 12, 2014 at 7:58 pm

Bob, excellent article.

—snip—
So if Bitcoin gets killed it will probably be because of something that replaces it.
—snip—

Dogecoin is the most widely circulated crypto-currency on the internet. It’s only three months old and a fraction of a cent to own. Will it replace Bitcoin? Time will tell.

Eric
March 12, 2014 at 8:19 pm

You know Bitcoin is a serious currency when the monetarists attack it. A critic will try to pass his own flaws onto his opponent. In this case the real Ponzi schemes are the fiat currencies whose values can be changed at the whim of a government, or central bank. I understand several Wall Street firms have recently invested in Bitcoin trading, so there must be something to it.

giulio
March 12, 2014 at 11:48 pm

Bitcoin will remain, bit it will not be accepted as mainstream currency until trust and security are addressed. Its the preferred currency of the internet underbelly, so it will remain for some time or, when, like you said, something better replaces it.

Jason
March 13, 2014 at 4:01 am

Nice to see Bob somehow coming around into considering bitcoin, I didn’t have much hope of that ever happening.

The thing with Mt.Gox is that they lost not only their customers bitcoin but they also lost their customers dollars, and euros, and yen. Mt.Gox was acting as an exchange where you could buy and sell bitcoin, but the site was vulnerable to hackers due to weak code and, it seems, a staff not good enough to keep the site secure. It is funny the media only focused on the bitcoin loss, ignoring the incompetence of the site owners.

On another matter, there are other exchanges still going and they are not having the problems that MtGox had. Some are more reliable than others, but if you have bitcoin and you want to trade you cannot just keep it in your wallet, it makes no sense.

Myself I treat bitcoin and other crypto currencies like stock and trade between them in a small scale. It is both fun and profitable while we provide liquidity to the market. Anybody can trade starting with a few hundred $ invested and learn in the process.

There is also a very active and fun bitcoin community on reddit and on the bitcointalk.org forum. Start using it for fun guys, and learn in the process.

Fred Wilson, Principal, Union Square Investors, Primary investor of Tumblr said this of Bitcoin:
Union Square has invested $2.5 million in BitCoin.
The value to business is not investing in bitcoins. The value is using it for currency exchange, pounds to dollars for example. The “exchange rate” is a tiny fraction of traditional banks, freeing large multinational to move currency around the world.

You must be thinking of some other metal when you say that the only use of gold is as money. Gold has a substantial demand for use as jewelry and for various industrial uses.
.
The problem with using fiat currency as money is the tendency of governments to devalue the currency by issuing too much of it. Fiat currency is created out of thin air and has no natural limits of how much can be issued.

Mr Windows
March 13, 2014 at 11:43 am

So Bitcoin (and other digital ‘currencies’) are essentially crypto-keys that have been cracked (‘mined’) and/or exchanged. They have absolutely no intrinsic value, in that they are not really backed by anything, no gold, no platinum, no full faith and credit of any sovereign bank. Some shadowy figure (ostensibly named ‘Satoshi Nakamoto’, but for all intents and purposes could very well be Li Keqiang , Vladimir Putin or Kim Jong-un) created Bitcoin and awards amounts of Bitcoins depending on how many mathematical problems you are able to solve…Somewhat like code-breaking…hmmm…
But, I can ‘Mine’ these Bitcoins by solving these mathematical puzzles and exchange these for nifty little things like virtual clothes in my favorite online role-playing game, or marijuana at my local dispensary…and other people accept these ‘Bitcoins’ in exchange for their goods and services…even though they have no intrinsic value.
And if I store them in an ‘exchange’, which is not a bank but merely a low-grade escrow service which is not insured and is also run by shadowy non-people, I run the risk of having them ‘stolen’ by other shadowy figures (who have presumably hacked into the ‘exchange’ and are not in actual fact the people running the ‘exchange’ in the first place).
People, do I look like I have S-T-U-P-I-D written all over my face?

But gold and platinum also have no intrinsic value. Surely goods, services, production and property are the only things that have ‘real’ value, and even then only when there’s consensus (cf. many homemakers don’t get paid for labor).

Actually, this applies to all currencies. Consensus is the key to a currency being accepted as payment, and it seems that despite the shaky start and frequent problems, some people share a consensus that Bitcoin continues to serve as a means of payment. Surely that’s really all that matters.

Eric B
March 13, 2014 at 2:09 pm

Consensus is key to gold and platinum being accepted as currencies also. Those two metals have the advantage of being difficult to mine, of limited supply, nearly impossible to destroy therefore long lasting, and difficult to fake. Lets face it, gold was currency for ages before paper money.

Oco
March 13, 2014 at 8:03 pm

Mr Windows this is so wrong that it is not even worth responding.
Please go kiss you banker and most importantly keep your dollar in banks it is essential.

R
March 14, 2014 at 2:02 am

Satoshi doesn’t issue Bitcoins. Except for claiming that he isn’t Dorian Satoshi Nakamoto, he hasn’t been heard from in years, and Bitcoins continue to be issued. The algorithm issues the Bitcoins.

The entire system is open source so everyone, Mr Windows included, has the option to look at it and investigate what it does; and everyone can see that the mining algorithm is completely useless for code breaking. I wrote a mining kernel for my own graphics card, so I know what I’m talking about.

Bitcoins have no intrinsic value, but that’s no different from fiat currencies. The dollar has the extrinsic value that I can pay for taxes or oil with them. The Bitcoin has the extrinsic value that I can send money to anybody anywhere in the world without high transaction fees. As long as I can find somebody willing to give stuff or fiat currencies for Bitcoins, then Bitcoins are valuable.

Ronc
March 14, 2014 at 5:24 pm

Yes. (I couldn’t resist )

Martin
March 13, 2014 at 12:02 pm

Oh yes, one other things that bit coin has that fiat currency doesn’t have is value based on rarity.

There can only every be 21 million or so, so if you own some percentage of that total, it can never be devalued by the govt or anyone just printing more. This is why gold and diamonds are precious, because they are rare (and attractive). I don’t know what proportion of the Earth’s total gold has been mined, but there’s probably an awful lot more than could be mined if the price went up.

John
March 13, 2014 at 1:20 pm

I find bit-coin an interesting concept. I can’t use it to pay my mortgage, taxes, utilities, food, etc. So how does it help me? This feels like a solution in search of a problem.

R
March 14, 2014 at 2:19 am

Essentially, Bitcoin is an experimental electronic money system that is controlled by a decentralized algorithm and not by central banks. If it succeeds, it could complement or replace fiat currencies such as the Argentinian peso or the Zimbabwean dollar. If it’s wildly successful, it could replace the US dollar.https://bitcoin.org/bitcoin.pdf

As a class of money, it’s inherently deflationary, which is attractive to many Libertarian-leaning members of society, and horrifying to the more Liberal economists. So, an investment in Bitcoin now could turn into durable savings in the future. Or it could collapse into nothing.

In this highly speculative era of Bitcoin’s development, I managed to turn a $75 penny investment in video cards into $1500 for my new MacBook. I still have most of my Bitcoins, and I still do casual gaming with those video cards. So, Bitcoins have turned out nicely for me.

Maybe this is the classic problem for you (and me) we are way too early on things like this. There will be someone, probably in Junior High right now, who will see the right slant on the ideas, work out the problems, get the security right, and bam!! they are bigger than M$, Facebook and Elvis combined.

Rich
March 14, 2014 at 7:04 am

My question is simple but no one’s answered it yet:
As someone who’s not a speculator, drug dealer, or survivalist, why would I ever invest in or use bit-coins? I see the risk but I’m unable to see any advantage. Anyone???

Generally, people want gold coins to preserve wealth (ie. store value). BitCoin functions as a store of value, speculative volatility aside, with the added benefit of medium of exchange. In theory gold can be a medium of exchange, but practically speaking, unless you are a state govt or have a daughter to marry off, it’s not really.

WRT medium of exchange and store of value, there’s a bit of chicken and egg for those two. Gold has a few thousand years of history backing it up. BitCoin, not so much, that’s its risk. The more people use it for medium of exchange, the more likely it is to serve as a store of value.

So, not speculator, drug dealer, or survivalist, but techno-Libertarian. You know, if you search hard enough, you can find dismissive labels for yourself, too. I just find it fascinating, to have an electronic money that central authorities do not control, that can be sent around the world with no or very low transaction fees, and that can be anonymous if you try hard enough.

Bitcoins, like any other form of money, are worthless if the global economy collapses. The Bitcoin system actually stops working if the Internet goes down and transactions stop entering the global distributed ledger, so it’s pretty useless for desperate survivalist scenarios. Bitcoins might be nice for a dollar-euro-yuan hyper-inflation economic collapse scenario, but you’d have to be really optimistic about the Internet and pessimistic about central authorities to stash an appreciable amount into Bitcoins. I guess if you’re congenitally rich, like the Winklevosses, you could diversify your savings and investments with Bitcoins.

Steve
March 14, 2014 at 8:02 am

Bit-coin is not a currency, it is a speculative asset. Because it is not a currency it cannot be used in place of dollars in the marketplace. Any use of Bit-coins has to take into account the gain or loss on the purchase price of the coins themselves as they are converted to and from dollars and you own taxes on that difference. Several countries have already ruled this way and the US is expected to do the same relatively soon.

This means that normal commercial operations cannot use Bit-coins because the transaction costs are going to be very high. You have to capture all transactions and treat them just like stock sales. That is not scalable at the retail level, your tax return is going to be incredibly complex as you have to get the tax documents from all the retailers in order to fill them out. No retailer is going to be able to afford that level of documentation to you and the IRS unless they specialize in expensive luxury goods.

You can get away with it for the short term because there is not enough traffic for anyone to bother with it. That will not last. This article should help you educate the masses:

The interesting thing I haven’t heard anyone comment on yet is Bitcoins potential in micro-transactions. The currency is divisible into extremely small units.
Several micro-payment systems have been created in the past couple years and then folded due to transaction overhead. Here’s a need that bitcoin might serve.
Suppose the New York Times started charging 1/1000 of a bitcoin to read an article. Or Etzy allowing an artist to charge 1/100 of a bitcoin for a sketch. Bitcoin would need to be a little more stable or the pricing model would have to account roughly for fluctuations but why shouldn’t it work.
Government taxation may kill bitcoins use for large speculative trading, but I doubt the IRS will audit me for not declaring the $30 I converted to BTC for buying art from Etzy (assuming they could link my wallet to me personally).

Mimi Aurora
March 16, 2014 at 9:02 am

Speaking of throwing away money…

That half-megabyte image of a bitcoin on the front page is a real waste of bandwidth. Aren’t you trying to run a lean and efficient site on a shoe-string budget?

RogerMcK
March 16, 2014 at 11:09 am

Ahem,… it’s 23K – lighten up!

Mimi Aurora
March 16, 2014 at 1:39 pm

That’s because it has been fixed since I made that post, which was the intent of the post in the first place.

[…] policy but this week they apparently did so by auctioning 30,000 Bitcoins, a crypto currency I have written about before. This auction effectively legitimizes Bitcoins as part of the world economy. Am I the only one to […]

[…] policy but this week they apparently did so by auctioning 30,000 Bitcoins, a crypto currency I have written about before. This auction effectively legitimizes Bitcoins as part of the world economy. Am I the only one to […]